Wider QE would contravene Maastricht

States that are profligate should pay the price

by Meghnad Desai

Thu 17 Sep 2015

The European Central Bank should widen quantitative easing to achieve a uniform interest rate as a sine qua non for a single currency area, according to the suggestion in the OMFIF Commentary by Marcello Minenna and Edoardo Reviglio (14 August and 15 September). The policy would work by the ECB buying the debt of countries with bond yields above the norm ̶ presumably the German level. This selective intervention would, they argue, eliminate the differences in these intra-euro area yields.

The proposal is designed to use QE as a device to force 'ever closer union' which politics has so far been too slow to complete. There are some problems here which I wish to highlight. A deliberate policy to eliminate yield differences would look like the ECB condoning fiscal laxity. This may lead to a lawsuit at the German constitutional court in Karlsruhe questioning the legality of these actions. But even if that is not the case, it sets a precedent which would undermine fiscal discipline.

We have seen how Germany and France, the largest euro member states, violated the conditions of the stability and growth pact in the early years of this century. The divergences in the yields reflect the market's views about the capability of individual states to achieve fiscal norms.

Perhaps these norms are too tight, but that is part of membership of monetary union. It is a Gold Standard-type arrangement where there is no monetary sovereignty and consequentially strict fiscal discipline is required. The ECB would break the spirit if not the letter of the Maastricht treaty if it followed the advice of Minenna and Reviglio.

If there was already a political union, then the ECB could in principle be directed to create money against sovereign bonds to allow the federal authority to create physical assets such as infrastructure ̶ a form of ‘People's QE’, as has been argued in the UK by Jeremy Corbyn, the new Labour party leader. But such an action may compromise the independence of the ECB.

There is another comment worth making. The US is a single currency area with a single interest rate. But individual states have no sovereign guarantee for their debts and they borrow at whatever rate the market determines. This makes sense. If a state wants to be fiscally profligate, it should be ready to pay the price.

Lord (Meghnad) Desai is emeritus professor of economics at the London School of Economics and Political Science and chairman of the OMFIF Advisory Board.